The Tax Cuts and Jobs Act (TCJA) signed into law in December 2017 expands the benefits of 529 college savings plans to cover private school tuition for children in grades K through 12. Effective Jan.1, 2018, the law allows families the opportunity to fund 529 accounts and take tax-free withdrawals of up to $10,000 per year to pay for a child’s non-college-level private or religious school education. This is a significant development, especially when considering the rising costs of a private school education. In fact, according to the Private School Review, the annual cost to send a child to a private school exceeds the cost of one year’s tuition at an in-state public university.
529 college savings plans have long offered families at all income levels a tax-advantaged planning tool for affording the rising costs of a college education. Parents, grandparents or other individuals may contribute to 529s for the benefit of a young child and allow those dollars to grow tax-deferred for the next 18 years or so. When the child reaches college age, he or she may withdraw funds tax-free to pay for qualifying education expenses, including university tuition, books, computers and room and board.
Individual donors receive the flexibility to fund 529 plans in the manner that is most affordable to them, whether that be small monthly installments or larger annual gifts, free of gift taxes without the imposition of federal taxes on the investment gains. Additionally, donors can avoid federal gift tax on their 529 plan contributions when they give $15,000 or less per year, per beneficiary, or up to $30,000 per year, per beneficiary when donors are a married couple that files joint tax returns.
Under the new legislation, parents or grandparents with the financial means may take advantage of existing laws to superfund 529 plans for college and private school tuition for each of their children or grandchildren in one year with five years of tax-free dollars. For a single taxpayer, the maximum annual lump-sum contribution is $75,000 per beneficiary; married couples who file joint tax returns may contribute up to $150,000 to a 529 plan for each of their children or grandchildren. These contributions are free of gift taxes and can grow over the years free of capital gains taxes. Any gifts above these amounts will count against a taxpayer’s lifetime gift tax exclusion, which is doubled from the current level under the tax reform law to $11.2 million for individual filers or $22.4 million for married taxpayers filing joint returns. Theoretically, 529 plan beneficiaries may begin withdrawing up to a maximum of $10,000 per year when they turn kindergarten age to pay for schooling at a private institution or religious school and continue to take distributions at these restricted amounts for the next 13 years until they complete high school. At that time, they will be unrestricted in the amount of funds they withdraw each year for qualifying college-level education expenses, including tuitions, fees, room and board.
However, it is important to note that the use of 529 plan savings to pay for a child’s elementary or secondary school education at a private school or religious school is temporary; this benefit is set to expire on Dec. 31, 2025. That gives taxpayers potentially eight years to take advantage of the expanded use of 529 savings. It is critical that individuals meet with qualified advisors and accountants during the first half of 2018 in order to maintain their financial goals and maximize their tax savings in the current year and beyond.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com
The media is rightfully paying significant attention to the U.S.’s new tax laws effective for the 2018 tax year. However, foreign persons with direct or indirect ownership in certain U.S. entities and structures should not forget that they have an important and immediate new filing requirement effective for the 2017 tax-filing season, which begins in January 2018.
For taxable years beginning in 2017, foreign-owned domestic disregarded entities, including single-member limited liability companies (SMLLCs), must 1) maintain a set of permanent financial records, 2) obtain from the Internal Revenue Service (IRS) an employer identification number (EIN), and 3) file both a U.S. corporate income tax return and IRS informational reporting Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code).
Failure to file the return or maintain proper records could result in a penalty of $10,000 for each violation of the law.
Generally, the Internal Revenue Code (IRC) treats SMLLCs as disregarded for all tax purposes. This means that an SMLLC would not have any U.S. income tax or information-reporting requirements separate from its foreign owner. However, under the new rules, such disregarded entities owned by a foreign person are treated as a domestic corporation that must meet all of the reporting and recordkeeping requirements applicable to domestic corporations with foreign owners. This includes filing an income tax return even if the foreign owner is already filing a U.S. tax return to report the SMLLC’s activity. The tax return will provide only general identifying information, but the Form 5472 that must be attached includes disclosure of the SMLLC’s direct and indirect foreign owners and any transactions that occurred between the SMLLC and a related party (including but not limited to the owner). For this purpose, a foreign owner includes a nonresident alien individual, foreign corporation, partnership, trust or estate.
It is likely too late for applicable taxpayers to avoid the domestic disregarded entity filing and recordkeeping requirements in 2017. However, taxpayers do have an immediate opportunity during the first few months of 2018 to plan ahead and change their structures.
For example, an SMLLC may consider electing to be treated as a corporation for U.S. income tax purposes and take advantage of the U.S.’s new corporate income tax rate, which was has been reduced significantly from a high of 35 percent to 21 percent beginning in 2018. While this option may be acceptable and easy for some foreign owners of SMLLCs to do, it is not an ideal solution, since it will not eliminate the tax return filing requirement or, in some instances, the requirement to file Form 5472. In addition, if the SMLLC owns U.S. real property, there may be Foreign Investment in Real Property Tax Act (FIRPTA) issues.
Alternatively, if the SMLLC is owned by a foreign corporation and holds personal use property, the LLC may be liquidated and avoid a U.S. corporate tax return filing requirement going forward until the property is sold. However, this option may also yield future tax implications, including foreign tax consequences, depending on the SMLLCs activities and whether the foreign corporation owns other assets.
Before making any decisions, it is vital that taxpayers engage the expertise of accountants and advisors to conduct a thorough review of their unique circumstances and a careful analysis comparing all of the options available to them.
The advisors and accountants with Berkowitz Pollack Brant work with domestic and foreign individuals and businesses to comply with international tax laws, maximize tax efficiency and reduce unnecessary compliance costs.
About the Author: Arthur Dichter, JD, is a director of International Tax Services with Berkowitz Pollack Brant, where he works with multi-national businesses and high-net worth foreign individuals to structure their assets and build wealth in compliance with U.S. and foreign income, estate and gift tax laws. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
While many provisions of the Tax Cuts and Jobs Act (TCJA) will not be reportable by U.S. taxpayers until they file their 2018 tax returns in 2019, individuals and businesses with overseas operations must prepare now and, in some instances, apply provisions of the new law to their 2017 tax returns. Following are two important and timely provisions of the law that require immediate attention and planning.
Deemed Repatriation Tax
The TCJA introduces an immediate, one-time “deemed repatriation tax” on income that U.S. businesses earned and were previously allowed to hold overseas as untaxed profits since 1987. More specifically, the law requires businesses to presume they brought foreign earnings back to the U.S. in 2017 and pay taxes on that amount. The tax on these deemed repatriated earnings tax is 15.5 percent on liquid assets (or 17.5 percent on those liquid assets held by individuals) and 8 percent on investments in illiquid assets, such as plants and equipment (9.05 percent when the tangible assets are held by U.S. individuals).
Because the deemed repatriation tax is effective immediately, it requires taxpayers to quickly assess their tax liability on as much as 30 years-worth of foreign earnings through 2017, and convert those foreign earnings from local accounting and tax standards to U.S. tax standards and, ultimately, also into U.S. dollars.
While the law does allow U.S. taxpayers to elect to pay this obligation over an eight-year period, the first installment is due on the same day as the taxpayer’s federal income tax filing deadline without regard to extension. For example, an individual with foreign, untaxed earnings subject to this rule would need to make the first installment payment on April 16, 2018, even if the taxpayer receives a six-month filing extension. Should the taxpayer miss the initial installment due-date, he or she may lose the option to pay the deemed repatriation tax over the next eight-year period and instead be compelled to pay the entire tax liability up-front in one lump-sum payment.
This leaves U.S. multinationals with a very limited window of time to determine not only the amount of earnings they hold offshore under U.S. tax principles but also the tax rates that should apply to that income based on the liquidity of their foreign-entity balance sheets. Making this determination and deciding whether to allocate overseas earnings to liquid or illiquid assets for purposes of calculating the tax will be a time-consuming, burdensome process. For example, according to the law, stock held in a publicly traded company is a liquid asset because taxpayers may easily sell their shares for cash. Conversely, shares in a private company are considered illiquid assets, which would be subject to the lower repatriation tax rate of 8 percent or 9.05 percent.
Accuracy is key when calculating the deemed repatriation tax, and businesses should be prepared to substantiate their calculations with supportable facts in the event the IRS challenges their estimates. A good starting point for many businesses to comply with this law would be an earnings and profits (E&P) study on their untaxed accumulated offshore earnings and profits. An E&P study looks at the historical foreign earnings reported under local tax principles and recalculates those amounts under U.S. tax principles with the support necessary to pass IRS audit procedures.
Once an E&P study is complete, taxpayers should consider what other benefits may be available to lower their deemed repatriation tax liabilities. As an example, the law permits taxpayers to apply E&P deficits from one foreign company against the earnings of another. In addition, the law allows for taxes paid by the foreign corporation to partially reduce the deemed repatriation tax if the U.S. taxpayer is a C corporation. Generally, U.S. individual shareholders who in invest in foreign corporations are not allowed to take credit for foreign taxes paid at the foreign-entity level, but they may be able to do so by making certain elections. As such, it behooves businesses to engage professionals to appropriately and accurately calculate and support the required repatriation tax.
Looking beyond the deemed repatriation tax, the new tax law provides a participation exemption for C corporations to effectively exclude from future income those dividends they receive from certain foreign corporations. For example, distributions of earnings to a C corporation by its long-held foreign subsidiary may not be subject to a second level of tax upon repatriation of those earnings to the U.S. Yet, U.S. corporations will not be able to deduct or claim a credit on their federal U.S. income tax returns for any withholding tax that they pay abroad on those future dividends. With this in mind, U.S. individual taxpayers with an interest in a foreign corporation may consider establishing or converting an existing LLC to a C corporation to bring dividends from abroad to a U.S. corporation free of U.S. taxation. It is also worth noting that imposing a C corporation between a U.S. individual and a foreign corporation may result in a lower rate of tax upon ultimate distribution to the U.S. individual if the foreign entity is organized in a country that does not have an income tax treaty with the U.S.
Global Intangible Low-Taxed Income (GILTI)
One provision of the new tax law that will not go into effect until 2018 is the new anti-deferral regime known as Global Intangible Low-Taxed Income (GILTI). In an effort to prevent U.S. businesses from shifting profits offshore to low-tax countries, the TCJA imposes an annual tax on foreign income that exceeds 10 percent of a taxpayer’s return on all foreign depreciable assets, including plants, equipment and real estate. The law excludes from this calculation some items of income, most notably income that is subject to a local tax rate above 18.9 percent. The effective GILTI tax rate through 2025 is 10.5 percent for C corporations and as high as 37 percent for individuals and S corporations. Beginning in 2026, the rate is scheduled to increase to 13.125 percent for C corporations and remain at 37 percent for individuals.
Again, due to this preferential treatment afforded to C corporations, partnerships and other pass-through entities might consider converting to a C corporation in 2018 to avoid a potentially higher tax liability come 2019.
The provisions of the tax law that relate to outbound international matters are complex and will require further guidance from the IRS in the coming months. It is critical that U.S. taxpayers with overseas interest meet with qualified tax professionals to assess the entirety of their domestic and foreign operations and develop strategies to improve global tax efficiency going forward.
About the Author: Andre Benayoun, JD, is an associate director of International Tax Services with Berkowitz Pollack Brant, where he works with inbound and outbound multinational businesses and nonresident aliens on a variety of matters, including structuring for mergers, acquisitions and liquidations; planning for repatriation of profits ; treaty analysis; tax-efficient debt financing; and pre-immigration tax planning. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.
The Tax Cuts and Jobs Act (TCJA) that overhauls the U.S. Tax Code represents new, often more-favorable tax treatment for real estate business owners and investors. However, the full benefit of these provisions will require careful evaluation and planning as the IRS catches up to the new law and provides technical guidance.
Income Taxes for Individuals and Businesses
For starters, the new law reduces the top marginal income tax rate for high-income earners from 39.6 percent to 37 percent and doubles the estate tax exemption, which allows individual taxpayers to exclude from estate tax up to $11.2 million in assets, or $22.4 million for married couples filing jointly. At the same time, the TCJA establishes a permanent corporate tax rate of 21 percent, down from 35 percent, while also eliminating the corporate Alternative Minimum Tax (AMT).
Pass-Through Business Structures
Businesses that are structured as pass-through entities, such as partnerships, LLCs, S corporations and sole proprietorships, may, subject to limitations, receive a deduction as high as 20 percent on U.S.-sourced “qualified business income” (QBI) that flows through to their owners’ personal tax returns. The deduction, which also applies to property rental businesses, trusts and estates and to taxpayers who receive qualified REIT dividends, qualified cooperative dividends, and/or qualified publicly traded partnership income, is available only through 2025; in 2026, the law calls for pass-through business income to be taxed using the standard individual tax rates and brackets that are in effect at that time.
In general, the 20 percent deduction is capped at the greater of the following:
1) 50 percent of wages paid to employees and reported on W-2s; or
2) 25 percent of W-2 wages plus 2.5 percent of a business’s original cost of qualifying, tangible depreciable property that generate trade or business income, including buildings, equipment, furniture and fixtures.
When determining the allowable deduction, many rental real estate operations will need to consider that while they may have limited W-2 wages, they may also have significant qualifying tangible and depreciable property to help maximize the 20 percent deduction.
Real estate businesses may need to reassess their existing operations in order to realize the potential benefits they may gain from the new pass-through deduction. This can include a review of their existing structures and the tax liabilities or savings they may potentially receive from restructuring, perhaps as C corporations. In addition, applicable businesses should assess how they pay employees and independent contractors and how the new law will treat specific items of income, such as triple net leases or ground lease real estate rentals.
First-Year Bonus Depreciation
Under the new law, qualified tangible property acquired and put into service after Sept. 27, 2017, and before Jan. 1, 2023, may be eligible for 100 percent “bonus” depreciation in the year of purchase. This first-year bonus depreciation deduction will begin to decrease after 2023 until it will no longer be available in 2027. Prior to the TCJA, businesses were permitted to expense only 50 percent of the price they paid to acquire and put into service qualifying property or to make non-structural improvements to the interiors of nonresidential buildings in 2017. The rate was scheduled to decrease to 40 percent in 2018 and to 30 percent in 2019.
By effectively doubling the amount that businesses can write off in the first year for the purchase of all eligible assets, the new rules provide qualifying businesses with an immediate tax-saving opportunity to reduce the amount of profits that are subject to tax. Moreover, the law expands the availability of bonus depreciation in 2018 to “previously used” assets.
However, the new law specifically excludes from the definition of bonus-depreciation-eligible property qualified leasehold improvements; qualified restaurant and retail improvements; and replaced it with non-leased “qualified improvement property” (QIP), which the PATH Act identified as structural improvements to the interiors of nonresidential property that was placed in service after Sept. 27, 2017. It may appear that Congress intended to provide a 15-year recovery period for QIP and for it to be bonus-depreciation-eligible. However, until the IRS issues some form of technical correction, QIP will be depreciated over 39 years.
Section 179 Expensing
Beginning with the 2018 tax year, eligible businesses may take an immediate deduction of up to $1 million per year for the costs they incur to acquire qualifying improvement property and business assets, including computer software and qualified leasehold, retail and restaurant improvements. The amount of the deduction will be reduced, dollar for dollar, when acquisition costs exceed $2.5 million. Previously, the Section 179 deduction was limited to $500,000, and it began to phase out at $2 million.
As an added benefit, the TCJA also expands the definition of Section 179 property to include other improvements made to nonresidential real property, including roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems) made to nonresidential real property.
Net Operating Losses
Prior to the TCJA, businesses were permitted to carry back net operating losses (NOLs) two years or carry them forward 20 years to offset table income. Effective for the 2018 tax year, however, NOLs can longer be carried backward. Carryforwards will be limited to 80 percent of a business’s taxable income, but these NOLs may be applied against taxable income indefinitely. As a result of the tax reform law, businesses will need to adjust carryovers from prior tax years to account for the 80 percent limitation.
Business Interest Deduction
Generally, the TCJA limits the interest payments that businesses may deduct to 30 percent of adjusted gross taxable income beginning in 2018. The law reduces that limit further beginning in 2022. However, the law does provide a number of exceptions to this limit that are specific to real estate businesses and investors. For example, eligible taxpayers may elect to fully deduct interest accrued in the development, construction, acquisition, operation, management, leasing or brokerage of real property. In addition, there is an exception for taxpayers that are considered “small business” with average annual gross receipts of $25 million or less for the three most recent prior tax-year periods.
Under the new law, amounts not allowed as a deduction for a taxable year may be carried forward to future years, indefinitely, subject to restrictions that apply specifically to partnerships.
Congress spent the past several years debating the preferential tax treatment of management fees and other forms of compensation (in excess of salaries) paid to partners, managers and developers for a share of a business or project’s future profits. This concept of carried interest treatment survived Congressional wrangling over tax reform and will continue to be taxed at the favorable long-term, capital gains rate of 20 percent, rather than the maximum ordinary income rate, which under the TCJA is 37 percent. However, the new law does limit the tax treatment of these gains to apply only to assets held for more than three years or sold after three years.
Section 1031 Like-Kind Exchanges
Thanks, in large part, to the lobbying efforts of the National Association of Realtors and National Association of Real Estate Investment Trusts, Section 1031 exchanges of like-kind real estate property will continue to receive tax-deferred treatment under the TCJA. The law, however, did eliminate the availability of tax-deferred exchanges of personal property, such as art work, coins and other collectibles.
About the Author: John G. Ebenger, CPA, is a director of Real Estate Tax Services with Berkowitz Pollack Brant, where he works closely with developers, landholders, investment funds and other real estate professionals, as well as high-net-worth entrepreneurs with complex holdings. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
On September 27, 2017, President Trump and top Republican leaders unveiled the latest round of updates to what they see as the future of the Tax Code. While it remains to be seen whether the tax reform package in its current state will become the law, it is important for taxpayers to understand what the framework entails. Following is a broad overview of the new framework. If you have questions about how these reforms impact you, please contact your tax advisors and accountants.
- Reduce the current seven tax brackets into three with a top rate of 35 percent
- Increase the standard deduction to $12,000 for single tax filers and $24,000 for married couples filing jointly (almost double the current deduction amounts)
- Eliminate personal exemptions that are today worth $4,050 per person
- Preserve deductions for mortgage interest, charitable contributions, and retirement savings while eliminating many other deductions not yet specified
- Preserve tax credits for work and higher education
- Increase the child tax credit, which is currently worth $1,000 per child under 17
- Eliminate the alternative minimum tax (AMT)
- Eliminate the estate tax
- Reduce the corporate income tax to 20 percent
- Reduce the tax rate on profits earned by small businesses and pass-through entities to 25 percent
- Eliminate the corporate alternative minimum tax
- Apply a new maximum tax rate to income from pass-through businesses
- Allow at least five years of full expensing for capital investment
- Limit the interest deduction for C corporations
- Eliminate the Section 199 manufacturing deduction and other, non-specified deductions
- Preserve the research and development tax credit and the low-income housing credit
- Eliminate the current 35 percent tax on profits that U.S. businesses earn overseas and repatriate or bring back to the U.S.; move to a more territorial system for which U.S. companies would pay taxes solely to the foreign governments where they earn profits
- Impose a new, but unspecified, minimum foreign tax to protect against cross-border income shifting and base erosion
The advisors and accountants with Berkowitz Pollack Brant will continue to monitor tax reform efforts and update our clients as opportunities become clearer.
About the Author: Edward N. Cooper, CPA, is director-in-charge of Tax Services with Berkowitz Pollack Brant, where he provides business- and tax-consulting services to real estate entities, multi-national companies, investment funds and high-net-worth individuals. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.